Until the early 1980s, the dominant form of retirement income plans sponsored by corporations for their employees within the United States were defined benefit plans. Under defined benefit plans (DB plans), the employee's retirement benefits are amounts guaranteed to the departing employee and are insured by the PBGC. The employer's ongoing contribution to the plan is determined actuarially. Since 1974 and the enactment of ERISA, there have been at least fifteen legislative acts impacting qualified pension and profit sharing plans. Much of this legislation has made defined benefit plans less and less attractive for employers to sponsor and have made defined contribution plans more and more attractive. By far the most popular type of non-defined benefit qualified retirement plan to emerge during the past fifteen years is the 401(k) plan. These plans can be structured several ways and can optionally be either a profit sharing plan or an ESOP (employer stock ownership plan) plan. They allow employees to contribute an allowable percentage of pretax income into the plan, making them a very attractive long-term savings vehicle for retirement. Further enhancing the appeal of 401(k) plans for employees, is the ability for employers to make an optional matching contribution. Most 401(k) plans provide an employer matching contribution of some kind and allow employees to be pro-active in selecting the investment direction of their accounts. Employers are particularly pleased with the heightened awareness employees tend to have about the value of the 401(k) benefit plan. Employees often pay less attention to and appreciate less defined benefit plans--despite the fact that they may cost the employer more and prove more valuable to the employee. In addition to the above, employers have become aware of the costly nature of all employee benefits (i.e., due to the impact of medical inflation on medial benefits and the accounting rule changes impacting retiree medical and life plans--FASB statement 106). Consequently, employers are becoming increasingly cost conscious about all benefit offerings.
One of the effects of the recent trends in employee benefits described above, is that there are currently over 30 million employees participating in 401(k) plans--in 1974 there were none. Additionally, there has been an enormous increase in the number of highly compensated employees participating in non-qualified retirement plans due to benefit restrictions in qualified plans.
A common feature in defined benefit pension plans is a disability completion benefit. If the plan participant becomes disabled prior to retirement, the employer is obligated to continue funding on the employee's behalf until retirement. The employee is entitled to approximately the same level of retirement income as they would have received absent the disability (small differences are possible since salary increases between the date of disability and retirement must be estimated). The point is under defined benefit plans there is an established practice of providing an undiminished level of retirement income to employees who become disabled during active employment years.
In contrast, employers offering defined contribution pension and profit sharing plans have not historically provided an undiminished retirement benefit in the event of disability. Because of the recent shift from a pre-dominate reliance on defined benefit plans to more and more reliance upon defined contribution plans, millions of American employees are at risk of losing a significant portion of their retirement benefits in the event of disability (spouses and dependents are also at risk).
There are many ways to protect employees from this risk. For example, employers may be able to continue making contributions on behalf of a disabled employee. However, there are several legal hurdles that make this difficult to accomplish. IRC Code Section 415(c)(3)(c) includes a definition of disability that prevents employers from providing adequate benefits for the majority of disabled employees. If the employer does provide a disability benefit, they can either self insure the risk or insure it.
There are many different ways that insurance can be structured to cover the risk of losing defined contribution plan retirement benefits. For example: (1) the employer can pay for coverage either within the defined contribution plan or outside of it; (2) the employee can voluntarily purchase coverage either within the defined contribution plan or outside of it; or (3) the employer and employee can share the expense for coverage either within the defined contribution plan or outside of it.
In addition, the policy of coverage can be provided under either a group or individual contract. Coverage can provide either immediate benefit payments (payments made at the time of disability), or deferred benefit payments. If immediate, the benefit payments can be made internal or external to the defined contribution plan in a number of ways. In the final analysis such coverage will be structured according to the particular needs and desires of each sponsoring employer and the specific (legal and other) requirements of their existing benefit plans.
Given that this represents a huge existing marketplace for insurance companies in the disability insurance market, it is interesting to note that none have successfully entered it on a significant scale. There are no serious underwriting risks blocking entry into the market. The concern for "over-insuring" is easily offset by restrictions on the disabled person's ability to access funds prior to retirement. Some carriers have, on a very limited basis, provided coverage to highly compensated employees external to defined contribution plans. While coverage is underwritten with the intent to protect defined contribution plan retirement benefits, the policies used thus far have been policy forms that were originally designed and priced to cover other loss of income risks.
To date, disability policies have not been made available to the entire employee population of a defined contribution plan--either within the defined contribution plan or external to the plan. To date, disability policies have not been made available to participants (either to all plan participants or even a sub-grouping of plan participants) within a defined contribution plan.
Historically, disability policies offered to protect participant contributions (employer and or employee paid) to defined contribution plans, have been made available only on a very limited basis (i.e., never offered to more than 1/3 of a plan's participants). Additionally, they have only been offered external to the defined contribution plan. Less than 100 of these limited, external employer sponsored plans have been underwritten during the past five years. Only two or three carriers have been willing to offer polices to defined contribution participants. This coverage has been offered on a guaranteed issue basis. Other carriers are not prepared to offer individual policies on a guaranteed issue basis.
One major insurance carrier, a leader in offering administrative services for 401(k) plans, attempted to make a disability policy available to 401(k) plan participants. They were forced to withdraw the product from the market shortly after introduction. Their outside legal counsel discovered that the way they structured the policy offering within the 401(k) plan caused the 401(k) plan to be in violation of ERISA rules--thus subjecting the sponsoring employer to potential fines or plan disqualification.
Another leading disability carrier attempted to market a rider to their existing group long term disability (LTD) plans. The rider would be purchased voluntarily by persons covered under the employer sponsored LTD plan who were also participants of a 401(k) plan. The rider was designed to protect 401(k) contributions. Thus far, interest in offering the rider to employees has been minimal. In the few situations where employers have consented to allow the carrier to offer the rider to their employees, participation has been extremely low. The carrier considers the entire initiative a failure and is seeking other ways of making coverage available so that participation reaches more successful levels.
Most defined benefit plan disability protection offered by employers is self-insured. Annual plan contribution levels are determined actuarially. The amount needed to fund for current and future disabled participants is included in the actuarial formulas. Therefore, disability insurers have not developed computer systems to cover all employee participants of defined benefit pension plans.
In most of the established disability markets (both group and individual) the policy is sold to the covered person directly or is sold to them indirectly through some form of sponsorship--an employer makes coverage available to employees or an association makes coverage available to members. Employers also provide coverage on a non-contributory basis to employees. In all of these situations, the insurance carrier usually has to deal with only one, two, or three parties at most:
1. The covered individual if coverage is sold to them directly; PA1 2. The covered individual and employer (or association) if coverage is sold through employer (or association) sponsorship--whether contributory or non-contributory; or PA1 3. The employer if coverage is provided on a non-contributory guaranteed issue basis. PA1 1. Premiums are paid within a qualified pension or profit sharing plan (ERISA trust) with disability benefits payable to the qualified pension or profit sharing plan (including to an annuity contract within the trust). PA1 2. Premiums are paid within a qualified pension or profit sharing plan (ERISA trust) with disability benefits payable to the plan participant who is disabled. PA1 3. Premiums are paid within a qualified pension or profit sharing plan (ERISA trust) with disability benefits payable to a group or individual annuity outside of the qualified pension or profit sharing trust. PA1 4. Premiums are paid within a qualified pension or profit sharing plan (ERISA trust) with disability benefits payable to a non-qualified trust which may hold funds in various investments including group or individual annuities. PA1 5. Premiums are paid outside a qualified pension or profit sharing plan (ERISA trust) with disability benefits payable to the qualified pension or profit sharing plan (including to an annuity contract within the trust). PA1 6. Premiums are paid outside a qualified pension or profit sharing plan (ERISA trust) with disability benefits payable to the plan participant who is disabled. PA1 7. Premiums are paid outside a qualified pension or profit sharing plan (ERISA trust) with disability benefits payable to a group or individual annuity outside of the qualified pension or profit sharing plan trust. PA1 8. Premiums are paid outside a qualified pension or profit sharing plan (ERISA trust) with disability benefits payable to a non-qualified trust which may hold funds in various investments including group or individual annuities. PA1 9. Premiums are paid in a qualified Section 125 Welfare Benefit Plan trust with disability benefits payable to the qualified pension or profit sharing plan (including to an annuity contract within the trust). PA1 10. Premiums are paid in a qualified Section 125 Welfare Benefit Plan trust with disability benefits payable to the plan participant who is disabled. PA1 11. Premiums are paid in a qualified Section 125 Welfare Benefit Plan trust with disability benefits payable to a group or individual annuity outside of the qualified pension or profit sharing plan trust. PA1 12. Premiums are paid in a qualified Section 125 Welfare Benefit Plan trust with disability benefits payable to a non-qualified trust which may hold funds in various investments including group or individual annuities. PA1 13. Premiums are paid in a qualified IRC Section 501(c)(9) Welfare Benefit Plan or VEBA Trust (Voluntary Employee Beneficiary Association) with disability benefits payable to the qualified pension or profit sharing plan (including to an annuity contract within the trust). PA1 14. Premiums are paid in a qualified IRC Section 501(c)(9) Welfare Benefit Plan or VEBA Trust (Voluntary Employee Beneficiary Association) with disability benefits payable to the plan participant who is disabled. PA1 15. Premiums are paid in a qualified IRC Section 501(c)(9) Welfare Benefit Plan or VEBA Trust (Voluntary Employee Beneficiary Association) with disability benefits payable to a group or individual annuity outside of the qualified trust. PA1 16. Premiums are paid in a qualified IRC Section 501(c)(9) Welfare Benefit Plan or VEBA Trust (Voluntary Employee Beneficiary Association) with disability benefits payable to a non-qualified trust which may hold funds in various investments including group or individual annuities. PA1 17. Premiums are paid in a qualified IRC Section 419 (e) Welfare Benefit Plan with disability benefits payable to the qualified pension or profit sharing plan (including to an annuity contract within the trust). PA1 18. Premiums are paid in a qualified IRC Section 419 (e) Welfare Benefit Plan or VEBA Trust (Voluntary Employee Beneficiary Association) with disability benefits payable to the plan participant who is disabled. PA1 19. Premiums are paid in a qualified IRC Section 419 (e) Welfare Benefit Plan or VEBA Trust (Voluntary Employee Beneficiary Association) with disability benefits payable to a group or individual annuity outside of the qualified pension or profit sharing plan trust. PA1 20. Premiums are paid in a qualified IRC Section 419 (e) Welfare Benefit Plan or VEBA Trust (Voluntary Employee Beneficiary Association) with disability benefits payable to a non-qualified trust which may hold funds in various investments including group or individual annuities.
In addition to the above, the insurance carrier may work with a trustee of a welfare benefit trust established by the employer or association. Insurance companies may also use third party administrators to perform some or all of the administration associated with offering traditional disability coverage. Historically, the computer systems used to provide disability coverage and administer it on an ongoing basis has been limited by needs attendant to the scenarios described above.
Although several carriers have attempted expand from these traditional markets into the defined contribution plan market by offering some form of protection to participants, thus far they have been largely unsuccessful. There are over 30 million 401(k) plan participants alone--less than 20 thousand have coverage protecting 401(k) retirement benefits from disability (either employee paid or employer paid). None of these existing policies are provided within the 401(k) plans.
None of the carriers trying to enter into the disability coverage for defined contribution plan market have figured out what is required to offer coverage in the plan. None have figured out what it takes to offer disability coverage to all participants of defined contribution plans--either in the plan or external to the plan. None have identified what is required to efficiently deal with a all of the additional laws pertaining to the ongoing tax law and labor law qualifications of each type of qualified defined contribution plan.
Because a full knowledge of the rules is required in order to assure ongoing defined contribution plan compliance and qualification, none have been able to offer a disability product (either group or individual) to employers or employees other than on a basis where the rules can not be violated (i.e., outside of the plans to a small group of participants).